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Ties That Bind: Estimating the Natural Rate of Interest for Small Open Economies

Valerie Grossman, Enrique Martinez-Garcia, Mark Wynne () and Ren Zhang ()
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Enrique Martinez-Garcia:

Authors registered in the RePEc Author Service: Enrique Martínez García ()

No 359, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: This paper estimates the natural rate of interest for six small open economies (Australia, Canada, South Korea, Sweden, Switzerland and the U.K.) with a structural New Keynesian model using Bayesian techniques. Our empirical analysis establishes the following four main findings: First, we show that the open economy framework provides a better fit of the data than its closed economy counterpart for the six countries we investigate. Second, we also show that, in all six countries, a Taylor (1993)-type monetary policy rule that tracks the Wicksellian short-term natural rate fits the data better than a rule that does not. Third, we show that the natural interest rates of all six countries have shifted downwards and strongly comoved with each other over the past 35 years. Fourth, our findings illustrate that foreign output shocks (spillovers from the rest of the world) are a major contributor to the dynamics of the natural rate in these six small open economies and that those natural rates strongly comove also with the existing U.S. natural rate estimates.

Keywords: Small Open Economy Model; Monetary Policy; Natural Rate; Bayesian Estimation (search for similar items in EconPapers)
JEL-codes: C11 C13 E43 E58 F41 (search for similar items in EconPapers)
Pages: 55
Date: 2019-03-31, Revised 2021-03-05
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-opm
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DOI: 10.24149/gwp359r1

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